The puzzle of ESG taxonomies

The lists of virtuous and harmful activities in terms of sustainability are upset by the war in Ukraine.

The taxonomy is one of the tools provided by the European Union (EU) and by other jurisdictions to stimulate the development of the green economy and sustainable investment (integrating environmental, social and governance, ESG criteria). This involves establishing lists of economic activities according to their beneficial or harmful nature to the environment (green taxonomy) and to society (social taxonomy).

Historically, certain trends in responsible investment have been built on the basis of this type of classification. Thus, sectoral exclusions are based on the idea that certain activities and products are inherently harmful (alcohol, tobacco, pornography, gambling and other sin stocks, or “actions of sin”). Conversely, impact investing promotes activities considered positive such as organic farming, microcredit or access to health; as for the sustainable thematic investment, it takes for example cleantech, renewable energies or even water treatment technologies.

The development of ESG taxonomies is the subject of intense debate. At the beginning of February, the European Commission announced its intention to include gas and nuclear in the new version of the European green taxonomy. NGOs, investors and experts reacted negatively, fearing that this expansion would weaken the scope of the taxonomy. At the end of February, following the outbreak of war in Ukraine, things got even more complicated. Energy dependence on Russia, at the center of concerns, leads to calls for more investment in renewable energies but also, according to the interlocutors, in nuclear power, shale gas, and even in coal and oil.

Social taxonomy is also challenged by reality. According to the European SRI study 2018, controversial weapons are the most practiced exclusion in Europe (by 63% of investors surveyed). Weapons in general come third, behind tobacco, with 48%. Russia’s invasion of Ukraine is leading some to reconsider their position: the Swedish SEB Investment Management has just reconsidered its recent decision to exclude arms from its investment universe. He now considers that “investing in the defense industry is important to defend democracy, freedom, stability and human rights.”1 This decision should satisfy Latvia’s defense minister, who had recently complained that banks and institutional investors were refusing to finance a Latvian arms manufacturer under their ESG standards: “How can we develop our country? Is national defense not ethical?”2

Some of the investors who had not previously ruled out armaments are now considering increasing their exposure to this sector3. Finally, according to Citigroup, it is now unlikely that armaments will be excluded from the European social taxonomy4a prospect that thrills the ecosystems of sustainable finance.

1650444969 101 The puzzle of ESG

As recent events illustrate, ESG taxonomies based on lists of products and services are hotly debated and seem difficult to implement. Norges Bank Investment Management, which manages the Norwegian sovereign wealth fund, questions the “feasibility” of the social taxonomy planned by the EU, and declares that it prefers evaluations of the conduct of companies to product evaluations.5. For Kari Vatanen, CIO of Finnish insurer Veritas, “blacklists are not a good tool for ESG, as they are based on ethical standards in a given context that can change drastically over time.” He prefers engagement with invested companies6.

Kiran Aziz, head of responsible investments at the Norwegian pension fund KLP, said he could only invest in arms manufacturers if they can prove that their products “are not used in illegal conflicts”. This approach is interesting, because it opens the door to the notion of “responsible sales”, where the issue is not so much the product itself as its user and the conditions of use; it is likely that in the future the behavior of companies will be increasingly analyzed in this light (think of technology, artificial intelligence, robots, etc.)7.

But is it possible to master the use of weapons? This is not the opinion of Herve Guez, CIO of Mirova: “weapons manufacturers do not have the means to choose their customers and refuse contracts with undemocratic regimes.” This is also the opinion of Jon Hale, director of sustainability research at Morningstar.8. Finally, as his colleague Ollie Smith reminds us, the weapons are difficult to control and can be found in other contexts years after their acquisition, because they are made of “durable” metal (in the sense of “that lasts”). ) … A real headache.

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The puzzle of ESG taxonomies


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